The Indian equity markets have rallied strongly after the sharp dip noticed last year, with the onset of Covid. Since then, Nifty has rallied by closer to 110% and the Smallcap Index by more than 200%. Several retail investors have been unable to participate in this upsurge. This “left out” feeling is pressurizing several of them to participate, now. So, should they, is a common question that is so often asked?
Our observations and submissions are given below. We hope, they provide some clarity to the investors. However, readers would do well to do their own diligence before taking any actions.
- Covid which was the reason for the dip in the markets, last year, continues even now. However, several countries have been able to reduce the infections dramatically, especially among the developed ones. The developing and the underdeveloped countries are still fighting it. However, after a year, it is a known devil and hence most governments are facing it diligently. Vaccination is on in full swing wherever it is available. Life is almost normal in several countries like US, China, Australia, etc. In India, vaccination has yet to gain momentum due to supply issues. Hopefully, in the next few months these issues would be sorted and a larger number of people would have access to it. One only hopes that these vaccines are effective against the mutating virus!!
- Lockdowns continue in India, but, in a diluted form. Except for some sectors like tourism, malls, multiplexes, aviation, etc. rest of the sectors are witnessing a re-start in activity. Even if the virus maintains a status quo at today’s levels, in India, economic activity may be restored to pre-Covid levels. Several sectors of the economy are preparing for a strong resurgence in demand once there is some semblance of stability. The GDP growth in FY22 and FY23, could be strong, largely due to the base effect.
- Most central banks have followed an easy money policy, for over a decade. Hence, there is ample liquidity globally, a large part of which is finding it’s way into equity markets. With interest rates negative, in several countries, there are very few asset classes that can generate returns for investors, equities being one of the primary ones.
- Commodity prices globally have begun to inch up due to resurgence in demand as economies open up and also due to heightened speculative activity due to an ocean of liquidity. Production capacities of several commodities were cut down due to paucity of demand and also due to pollution concerns, in the past. Due to this surge in demand, it is possible that demand may outstrip supply in the short to medium terms, keeping these prices elevated. For India, increase in oil prices is a cause for concern. Resultantly inflation concerns are inching up and a section of the economists have begun to predict change in the stance of the central bankers. Bond yields too have begun to inch up globally. These developments donot augur well for equity markets.
- Given this backdrop, what are the expectations from corporate results, in India? It all depends on how the infections behave and the concomitant government response. However, as of now, businesses have begun normalizing their activities. The strong economic growth that is expected, should percolate down and should result in strong corporate results in FY22. FY23 is also expected to be strong in terms of volume growth. However, with commodity prices inching up, margins may come under some pressure.
- So, are the valuations factoring in this growth? The sharp run up in markets have made several stocks quite expensive. In several cases, we find mid and small cap stocks enjoying richer valuations than their larger and stronger peers. It is not hard to find companies that have their FY23 earnings estimates discounted more than 50x. However, as the economic recovery broad bases, several ignored sectors like textiles, realty, commodities, infrastructure, etc have begun to attract investor attention. Most of the stocks in these sectors are either mid or small caps. Hence, it may be possible that stock specific activity continues to attract attention, even if the sentiment takes a turn.
- The primary market is buzzing with activity. Numerous existing and new companies are raising funds from the current buoyant markets. Most of these companies have satisfactory fundamentals but the valuations are very rich. Several “new-age” businesses have also joined the bandwagon, in wanting to capitalize on current exhuberance. It is very hard to value these businesses as many of them are making losses. Investors are lapping them up in the hope that at some point in future, they would make profits! We at Capital Portfolio Advisors, being conventional and conservative in our approach, are staying clear of these “new-age” businesses, if they are loss making.
There are several other data points, tangible and intangible, that indicate that the markets are exhuberant and may not afford a good risk-return trade-off. Mid and small cap stocks tend to sell off sharply, once the sentiment turns, catching most retail investors off guard. Hence, anyone itching to invest in these markets should ensure that there is a good margin of safety. Else, it may be a good idea to wait for an opportune time. Sometimes wisdom lies in inaction!!
Stay safe and happy!
Disclaimer
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